The buzz surrounding a potential central bank-backed digital currency grew louder this week, as the Bank of England and Treasury announced they would launch a taskforce to look into a potential digital pound.
Dubbed "Britcoin" by the press, the BoE said any UK digital currency would be a new form of digital money that could be used by both households and businesses. It would exist alongside cash and bank deposits, rather than replacing them. Both the BoE and Treasury stressed they were simply exploring the idea and are not committed to launching "Britcoin".
Interest in central bank digital currencies — often abbreviated to just CBDC – has evolved from the growth of decentralised digital currencies such as bitcoin (BTC-USD) and ethereum (ETH-USD), which have taken markets by storm.
Dutch bank ING said discussions of national digital currencies began with the emergence of bitcoin but were "mostly academic" until Facebook's decision to launch its own digital currency in 2019.
"All of a sudden, the prospect of a private stablecoin crowding out fiat currencies and pushing central banks into irrelevance turned into a real possibility, given Facebook’s vast global user base," Teunis Brosens, ING's head economist for digital finance and regulation, wrote in a research note.
What is Central Bank Digital Currency (CBDC) and how does it work?
Like other forms of cryptocurrency, CBDCs are a form of virtual money that uses an electronic record or digital token to represent cash. It is issued and regulated by a country’s monetary authority, which in the UK is the Bank of England. This is a key difference to cryptos like bitcoin, which are decentralised and unregulated.
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Retail CBDC can be directly held by citizens and businesses. This is a step change from the current system where money is held at a bank. Instead of going to a cash machine to withdraw money from, say, Barclays, your money would instead be held directly on your mobile phone.
Interbank or wholesale CBDC is restricted to use by financial institutions like banks. It is used for big ticket bank-to-bank transfers and financial settlement processes.
CBDCs represent a new frontier for central bank stimulus, potentially acting as a conduit for policies such as stimulus checks, emergency loans, and UBI (universal basic income). Central banks could induce more powerful, directed "money drops" to stimulate the economy rather than tinkering with interest rates.
Which countries are looking at CBDCs and why?
According to PwC, retail CBDC projects appear to be more advanced in emerging economies.
China, Cambodia and The Bahamas are leading the pack, although the UK, Europe and the USA have all expressed an interest in developing their own CBDC.
Financial inclusion is often stated as a motivation, given that CBDC users do not need to be part of the banking ecosystem. With traditional money, people must have a bank account and a debit or credit card. With CBDCs, all they need is a phone.
PwC found that more than 60 central banks around the world have entered the central bank digital currency race since 2014, with 88% of the ongoing projects using blockchain as the underlying technology.
"As cryptocurrency investors ride a wave of speculation, the government will be keen to distance itself from what is still seen as the wild west of the payments world," said Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown.
"However, officials clearly believe they can’t ignore the surge of interest in digital currencies, as a means of faster and more efficient money transfers, particularly internationally."
Streeter said there was a do or die environment in the adoption digital currency. Not developing a policy could mean more power falls into the hands of big tech companies as consumers drift further towards crypto.
Which country might be first to launch?
China is close to becoming the first major economy to launch a digital currency. Pilots began regionally last year and there are rumours of a national launch in 2022.
The Bahamas has also been tipped by PwC's CBDC global index as a frontrunner in the race, followed closely by Cambodia.
No wholesale CBDC projects have launched yet but nearly 70% are running pilots. Only 23% of retail projects have reached this stage.
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Two projects are currently live and piloting: the Sand Dollar in the Bahamas and project Bakong in Cambodia.
The UK's taskforce has made clear that its project is in early stages. The European Central bank has said any possible "digital euro" will take several years.
Pros and cons
Many backers of digital currencies say banking this way is more efficient. Instead of relying on intermediaries such as commercial banks, money can be transferred directly to the recipient and payments can be made in real time.
There is also an argument that CBDC helps prevent illicit or fraudulent activity. CBDCs make it easier for central banks to keep track of the exact location of a unit of currency. Cash, meanwhile, can be laundered or 'lost' more easily.
Potential drawbacks include the invasion of privacy associated with this sort of surveillance. Governments could obtain access to private individual spending data, for example.
Another fear is that CBDCs could herald the onset of a fully cashless society, which could harm poor, rural, and elderly communities who largely rely on cash.
Central banks are also unsure of what the monetary policy implications would be of a fully cashless society. For example, if people can transfer money instantly and with zero friction, would bank runs be more common? Would commercial banks even still exist? And how powerful — or not — would interest rate adjustments become?
Questions like these are why governments around the world — particularly in major economies — are taking it slow when it comes to CBDCs.
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